Once markets get past all the noise, the COVID-19 vaccine is good news for gold, according to TD Securities.
“Vaccine should ultimately be a boon for gold bugs, as the Fed could keep nominal rates capped while inflation expectations could firm further as a result,” TD Securities strategists wrote on Wednesday.
The first response to positive vaccine news was a rally in stocks, and bond yields, while the precious metals tumbled down. The reason for that was because markets are beginning to price in the end of the pandemic even though serious questions about the potential vaccine rollout still remained.
“The positive news on the vaccine sent ten-year yields to their highest since the pandemic began. However, the rise in yields has been accompanied by strengthening in equities and tighter credit spreads, keeping financial conditions uber-loose, which raises questions as to why the Fed should intervene,” TD’s strategists noted.
The focus going forward will be on vaccine developers and the Federal Reserve. In this context, the central bank’s new average inflation targeting will benefit gold longer-term.
“Policymakers are actively attempting to stimulate inflation with a period of overshooting, which should keep uber-easy policies in place for the foreseeable future. Treasury supply pressures, rising real rates and Fed pricing inching closer to late 2023 from mid-2024 are all reasons that the Fed may step in to keep policy supportive and prevent an undue deterioration in financial conditions,” they said.
TD Securities expects the Fed to start favoring longer-dated bonds, which should cap ten-year yields around 1%.
“We argue that a vaccine should ultimately be a boon for gold bugs, as the Fed could keep nominal rates capped while inflation expectations could firm further as a result,” the strategists pointed out. “While this set-up suggests the bull market in gold remains intact, a reactive rather than proactive Fed is keeping the door open for the pain trade to grow in the near-term, as we enter into an uncertainty vacuum into the December meeting.”
Last week, Fed Chair Jerome Powell warned of further downside risks to the economy if coronavirus is not controlled and if there is not enough monetary and fiscal stimulus.
“Divided government will make fiscal easing difficult. Further, the Fed’s FAIT [Flexible Average Inflation Targeting] suggests a more dovish reaction function in the face of inflation that is well below the 2% target,” TD’s strategists said.
Markets are currently pricing in the first rate hike only at the end of 2023. December Fed meeting will be a key one to watch, the strategists added.
“The Fed has already shifted the intent of QE from market functioning to keeping financial conditions accommodative. We have been arguing that the next step would be to extend the WAM of its purchases. The Fed discussed this issue at the November meeting, and we expect a WAM extension at the December FOMC. This should keep the 10y capped around 1%,” they said.